May 2023 / United States

The Internal Revenue Service has discussed the process and criteria for business entity classification elections for federal tax purposes in a recent private letter ruling (202317009).

The IRS stated that under section 301.7701-3(a) of the Internal Revenue Code (IRC), a business entity not classified as a corporation under IRC under sections 301.7701-2(b)(1), (3), (4), (5), (6), (7), or (8) can elect its classification for federal tax purposes. An eligible entity with at least two members can choose to be classified as either an association or a partnership, while an entity with a single owner can elect to be classified as an association or to be disregarded as an entity separate from its owner.

For foreign eligible entities, IRC section 301.7701-3(b)(2)(i) provides that, unless the entity elects otherwise, it is considered:

• a partnership, if:
• it has two or more members; and
• at least one member does not have limited liability;
• an association, if all members have limited liability; or
• disregarded as an entity separate from its owner, if it has a single owner without limited liability.

Under IRC section 301.7701-3(b)(2)(ii), a member of a foreign eligible entity is considered to have limited liability if they bear no personal liability for the debts or claims against the entity by reason of being a member.

According to the IRS, to elect a classification other than the default provided in IRC section 301.7701-3(b), an eligible entity must file Form 8832, Entity Classification Election, with the designated service center. Per section 301.7701-3(c)(1)(iii), the effective date specified on Form 8832 cannot be more than 75 days prior to the filing date and cannot be more than 12 months after the filing date.

In the present case, the foreign eligible entity was formed under the laws of a foreign country and intended to be classified as a corporation. However, the entity failed to timely file Form 8832. Upon review, the IRS concluded that the requirements of IRC section 301.9100-3 have been satisfied and granted the entity an extension of 120 days from the ruling's date to make an election to be treated as a corporation for federal tax purposes.

On 22 May 2023, the US Internal Revenue Service (IRS) issued a news release (IR-2023-104) announcing interest rates on tax overpayments (i.e. tax refunds) and tax underpayments (i.e. tax assessments and late tax payments) for the calendar quarter beginning 1 July 2023 (Revenue Ruling 2023-11).

The interest rates, which apply to amounts bearing interest during the third calendar quarter, are as follows:

• 7% for non-corporate overpayments (payments made in excess of the amount owed);
• 6% for corporate overpayments;
• 4.5% for corporate overpayments exceeding USD 10,000;
• 7% for underpayments (taxes owed but not fully paid); and
• 9% for large corporate underpayments.

Note: Under the Internal Revenue Code, interest rates are determined on a quarterly basis. For taxpayers other than corporations, the overpayment and underpayment rate is the federal short-term rate plus 3 percentage points.

The IRS' Chief Counsel's Office released a memorandum (AM 2023-003) and advised on the application of the regularly traded exception in two different situations where a non-resident alien individual's gain on the disposition of a domestic corporation's stock could be treated as effectively connected income under section 897.

In its memorandum, the IRS asserted that the regularly traded exception should be assessed at the partnership level when a partnership owns stock of a US real property holding corporation (USRPHC). This means that if a partnership exceeds the 5% stock ownership threshold with respect to a corporation, stock of which is regularly traded on an established securities market, a foreign partner of the partnership is subject to US tax under section 897(a) on its allocable share of any gain from a sale of such stock by the partnership.

Accordingly, a foreign partner could be subject to US tax on the disposal of a publicly traded USRPHC even if the foreign partner does not indirectly own more than 5% of the stock sold by its partnership vehicle.

Section 897 pertains to the taxation of foreign persons on the disposition of US real property interests. It generally provides that when a foreign person sells or disposes of a US real property interest (USRPI), the gain from the transaction is generally subject to US taxation as effectively connected income. The term "USRPI" refers to any interest, whether direct or indirect, in real property located in the United States or in any domestic corporation that primarily holds USRPIs.

However, there is an exception known as the "regularly traded exception" provided under section 897(c). This exception applies when the USRPI interest is regularly traded on an established securities market and the foreign person holds no more than a 5% interest in the class of stock that represents the USRPI.